Thursday, May 16, 2013

Most of you know that we publish a premium newsletter each quarter called Hedge Fund Wisdom (HFW). It reveals the portfolios of 25 top hedge funds, provides hedgie consensus buy/sell lists, and features an equity analysis section written by hedge fund analysts. (If you haven't seen it, check out a free sample here).

The brand new Q1 2013 issue of HFW will be released next week (May 21st), but in the mean time we wanted to update everyone on the performance of the stocks analyzed in past issues. (After all, the newsletter has been running for almost 3 years now).

Performance of Stocks From Past Issues

Each HFW issue features an equity analysis section and all numbers herein assume each stock was purchased when each issue of the newsletter was released and held until present day (5/15/13). The numbers are pretty solid. Here are some stats:

- 36 stocks profiled through all issues thus far

- 26 of these stocks have outperformed the S&P 500

- Average performance across all stocks profiled = +51.2%

- Average performance of S&P 500 = +28.5%

- Average outperformance over S&P 500 = +22.7%

- The 26 outperforming stocks beat the S&P by an average of +41.2%

- 4 stocks have more than doubled (+177%, +156%, +148%, +137%)

- 5 other stocks have each almost doubled (+97%, +92%, +91%, +87%, +84%)

- Only 10 stocks underperformed the S&P (and only 1 had a negative return: -3.1%)

Quarterly Breakdown of Performance

Here's a quarterly breakdown starting with the most recent issue and working backwards:

Disclaimer (as noted at the bottom of this website and in the newsletters): This information is for educational and/or entertainment purposes only. Use this information at your own risk. Market Folly and Hedge Fund Wisdom are not investment advisors of any kind, so do not consider anything on this page to be legal, tax, or investment advice.

Tuesday, May 14, 2013

David Tepper appeared on Squawk Box this morning on CNBC. The once elusive Appaloosa Management hedge fund founder has now become somewhat of a sporadically recurring guest, each time popping in update his degree of bullishness.

Reasons For Tepper's Bullishness

He originally came on air in September 2010 and inspired the 'Tepper rally' in markets. The market is up almost 45% since Tepper's original bullish call and he said "sure, I'm definitely still bullish." He cited improvements in housing and autos as great reasons to be bullish in the US and also pointed to central banks around the globe that are easing. We highlighted Tepper's recent media appearance in January when he said to be long equities.

While many in the market are worried about the Federal Reserve tapering, Tepper shows how the deficit should be shrinking in the next six months and notes how there's $400 billion that can either go into the economy or stocks. "If we don't taper back, we're going to get into this hyperdrive market."

He went on to say, "There better be a true taper or else you might be back into the last half of 1999. So like guys that are short, they better have a shovel to get themselves out of the grave."

As far as potential risks go, Tepper says you always have to consider
potential problems arising in the Middle East that could cause a 5%
correction or so, but he doesn't see that coming and he also points that
North Korea has settled down a little bit.

In the end though, Tepper summarizes his thoughts by saying it feels like we're in an early stage economy.

Tepper on the Equity Risk Premium

Tepper highlights how "we're at one of the highs in equity risk premium in history" and that "when the equity risk premium is high, historically you get good returns after that. A chart he pulled up shows that the highest levels were in 1975, 1982 and now.

He also cited how there's a low 13-handle for the S&P on next year's earnings.

When asked where specifically he's bullish "I think every place is the place to be in the stock markets of the world. I think you've taken out the tail risk, the disaster case. That doesn't mean you won't potentially have riots in Europe."

Appaloosa Long Japan

Appaloosa is long Japan and has been long pretty much since the beginning of this year, Tepper said. They commented on how Dan Loeb of Third Point has approached Sony (SNE) about restructuring as well. Tepper noted that, "even though that market's moved a lot, you can still have a lot left in there."

Other Appaloosa Positioning

Tepper said, "It's one of those times where the indexes really are cheap ... My biggest position is Citi (C), you'll see it when my 13F comes out, it's still my biggest position. We don't own commodities, however if we still see a strong economy, as world growth picks up, commodities will pick up in 2014. General manufacturing is good, tech is cheap, but you have to be careful because of obsolescence" (so you have to look at individual names there).

He also said they still own Apple (AAPL), though they cut their stake a little bit at the beginning of the year around $500 or so. They bought just a little bit below $400, and he looks at it as part of his tech basket. Tepper feels the company either needs to come out with innovative new products, or transition to an evolutionary company where they make cheaper phones, bigger screens, and promote the ecosystem and grow that way. He says the problem is they haven't done either lately.

Adam Weiss and James Crichton's hedge fund Scout Capital filed a 13D on shares of DineEquity (DIN) yesterday after market close. Per the filing, Scout has revealed a 6.6% ownership stake in with 1,280,321 shares.

This means they've boosted their position size by 134,631 shares since the end of 2012, or around a 12% increase. They filed the 13D due to activity on May 3rd.

Activist Stake in DineEquity

In the fine print of the filing, we see that Scout's purpose of transaction is listed as follows:

"The Reporting Persons have engaged and expect to continue to engage in discussions with senior management of the Issuer with respect to the Issuer’s optimal capital structure, debt refinancing, timing and magnitude of share repurchases, management compensation metrics and merger and acquisition strategies, among other matters."

Per Google Finance, DineEquity "owns franchise and operate two restaurant concepts: Applebee's Neighborhood Grill & Bar, (Applebee's), in the bar and grill segment of the casual dining category of the restaurant industry, and International House of Pancakes (IHOP), in the family dining category of the restaurant industry."

John Paulson's hedge fund Paulson & Co has filed a 13D with the SEC regarding the new entity of Dex Media (DXM). Per the filing, Paulson & Co has reported a 10.9% ownership stake with 1,878,927 shares.

Dex Media came to fruition via a merger of Dex One and SuperMedia, both positions Paulson was previously long. As a result, they received a stake in the new entity after reorganization.

Per Yahoo Finance, Dex Media "engages in the publication and marketing of directories, which include Yellow Pages and White Pages in the United States. The company also offers Internet-based telephone directory and database marketing services."

Monday, May 13, 2013

Today we're pleased to present notes from the 2013 London Value Investor Conference. The event features well known investors presenting investment ideas and insight in order to benefit children's charities The SMA Trust and Place2Be. Summaries of each presentation are linked below:

Michael Price first came to London as an investor in 1984. At the
time few people in Europe used a balance sheet focused value approach.
Many companies were not covered by an analyst at all and this
encouraged Price as the lack of coverage made him feel that he was
discovering new opportunities. Price said that this was the opposite
situation that you find at recent Berkshire Hathaway annual meetings
where 40,000 people focus on one company. He said to find opportunity
you need to get off the beaten track.

Price's Investment Process

Price
talked about his investment process. Two-thirds of his portfolio is
made up of stocks that trade below two-thirds of their intrinsic value.
The other third are special situations e.g., firms involved in proxy
fights, liquidations or a fight for control. From his 40 years of
experience, excluding 2008 - he said we all need to forget about 2008 -
that type of value portfolio will weather the storms.

What’s important
is to buy cheap and be well diversified with at least 30-70 holdings.
When you are convinced that what you already own is cheap compared to
comparable businesses you add to it. When you have done lots of work
and you gain conviction about an idea you can take the stake up to 3 to
5% of your portfolio. Your top five positions might each be 5% of your
portfolio. If you have conviction you should add to holdings as they
get cheaper. He values businesses by asking what a potential owner
would pay for the whole company.

Be prepared to wait patiently. If
there is nothing to do, sit with cash. Cash is ammunition. An investor
should spend all of his or her time working on calculating intrinsic
values waiting for the market to throw out an opportunity. The
definition of luck is preparation meeting opportunity.

Bad news creates
opportunity: wait for bankruptcies, the death of a control person who
owns a large part of the business, litigation, government intervention
and accidents. Always look at the companies whose share price is most
down to find value. Price said he also likes investing in companies
where management has built up intrinsic value and made mistakes.

In
terms of market valuation today, Price said the market was reasonably
priced but there are still some opportunities to find securities that
trade at two-thirds of their asset value.

Long: Hospira (HSP)

Idea:
Long Hospira (HSP:NYSE). Hospira had been a growth story until the FDA
shut down one of its largest plants. The share price went from $45 to
$28 overnight. The growth investors sold to the value investors. Price
thinks that the company will have completely recovered in two years.

Long: Hess (HES)

Idea:
Long Hess (HES) Hess is a case where the management have stumbled.
Hess is involved in a proxy fight with Paul Singer’s Elliott
Associates. It trades at a 50% discount. Price thinks there is likely to
be four or five new directors. The company with be divided into two
parts and share buybacks with be agreed. Assets will be sold off. John
Hess is likely to step down. The outcome of the vote is due on May 16.
It is also possible that Hess may get bought out.

Michael Price said he
also likes US banks (not European banks, though). He thinks Berkshire
Hathaway is 20% overvalued.

Continuing our notes from the London Value Investor Conference 2013, the next speaker is distressed investor Howard Marks of Oaktree Capital. He shared an outlook similar to what he's been writing. However, he did highlight where a lot of his portfolio has been allocated.

Marks is the author of one of the best investment books ever written, “The Most Important Thing". The book has recently been reissued as “The Most Important Thing Illuminated” with commentary by Seth Klarman, Joel Greenblatt, Christopher Davis and Paul Johnson, making the already outstanding volume even better.

Marks has done a lot of interviews and presentations recently. For those who have seen these and avidly read his regular memos there honestly was not a lot new in the London presentation. If you missed those, one of his last memos touched on how he thought equities were in stage 2 of a bull market.

One fascinating thing Marks alluded to in the Q&A, though, was that he views single b as the sweet spot in corporate bonds. He said “most bonds in my portfolio have been single b for years.”

James Montier said that GMO’s 7 year asset allocation model for US stocks is now predicting negative returns. GMO are now 50% in cash. While they've been known to hold higher levels of cash than most investors, this seems to be taking things a step further. They still hold some investments in Japan but he indicated that they are likely to be selling over the next couple of months.

He said that a year ago the model was indicating good returns in Europe but now it only suggests 2.5% real return per annum. He said that they are a bit frightened to follow the model in Europe because of the leverage at the company level, particularly in the financial sector.

Their model suggests that the best value is in emerging markets where 6% real is forecast. However, he mentioned that the research by his colleague, Edward Chancellor, which has identified an asset bubble in Chinese real estate, has made GMO cautious and led them to allocate less to EM than the model would suggest.

It is clear that at certain times GMO are prepared to overrule their quantitative asset allocation models when other evidence suggests caution.

Along with Neil Woodford, Anthony Bolton is probably one of the UK’s best known fund managers. Over a 28 year period from 1979 to 2007 Bolton returned 19.5% annualised managing the Fidelity Special Situations Fund.

He retired in 2007 and came out of retirement to run the Fidelity China Special Situations Fund in 2010. He is the author of a very good book on value investing “Investing against the Tide: Lessons from a life Running Money”.

Anthony Bolton was interviewed by David Shapiro. His answers fell into two broad categories: investment process and China.

Bolton on Investment Process

Bolton said that he had been influenced by many people over the years and that he had picked things up from here and there. He said “we are all plagiarists, what matters is how you mix it together.”

The two things that set Bolton apart from most other value investors are that he finds charting/ technical analysis useful and interviews with management are very important to him. Bolton said that he finds technical analysis gives a second view that is completely different and often more clear cut than fundamental analysis. When the technicals and the fundamentals line up Bolton said it gives him the conviction to make bigger bets.

When Bolton started visiting companies to interview managements in the 1970s it was unusual . He said that the interviews are a hugely central part of his process, even in China today. The only thing that he regards as more important is the dynamics of the business model.

Not being able to speak the language has not diminished the usefulness of the interviews. He said that he is used to having to work with translators in both Europe and China. Two-thirds of his interviews are currently carried out in Mandarin.

Having done a lot of interviews over the years, Bolton said that he has developed a feel for CEOs “who have it”. He looks for managers that can talk strategically and financially. What he does not like is a CEO who cannot talk about the financials well. He has found that to be dangerous trait.

Bolton regards the second interview with a company’s management as particularly important as it provides test of whether they say the same things or not. Bolton mentioned a number of characteristics of businesses that can provide him with investment opportunities. He likes companies that have a possible M&A angle. He looks for a discount to asset value. He looks for unrecognised growth. Changing businesses can create opportunities.

Generally he has not liked manufacturing and prefers cash generative rather than capital intensive businesses. Bolton says he has always tried to know more about the companies he is investing in than anyone else. It is only when he feels that he understands a situation really well that he is prepared to make a large bet. Bolton said that he makes a point of exploring what went wrong after he has made a bad investment. What he has found by looking at his mistakes over the years is that they mainly have two causes: a poor business model or too much debt.

On China

Bolton’s China fund has struggled since its inception in 2010. It was clear from his comments that his extensive experience in UK and European special situations had not prepared him for what he encountered in China. He said that the reverse merger Chinese companies listed in the US were the worst group he had ever seen. He estimated that about 80% were frauds.

Bolton lost some money in US reverse merger companies but he is now out of them. He warned that it is better to invest in companies in mainland China than those list on AIM or in the US. He prefers to invest in Chinese private companies rather than state owned enterprises.

Chinese official statistics are sometimes manipulated. Bolton said that you have to look at a range of figures like freight volumes and electricity generation to double check. He thinks that the road to social reform over the next ten years will be difficult for the Chinese. In the short term of a year or so he is expecting a big move up in Chinese equities.

Oldfield made some interesting comments about asset allocation. He said that his many years of experience have taught him that wholesale, large moves in a portfolio are usually disastrous. He recommended moving slowly. Investors are better to take marginal, incremental step as there is less chance of being wrong for emotional reasons.

Idea: Long Nokia

Oldfield said that Nokia was a great value but that they had got the entry price wrong. He noted the value in Navteq mapping, the half stake in NSM and intellectual property and patents. He said that the Lumia phones are very good and that capitulation for the stock is close at hand.

Idea: Long Hitachi

There has been a real change in style of Hitachi’s management. In particular it has become much more target orientated. It has become globally aware for the first time. It has a successful nuclear power venture. He noted that if Hitachi can be turned around then anything in Japan can. He said that there are many Japanese sleeping monsters with great potential. Last week we highlighted how investors are the Sohn Conference were bullish on Japanese stocks.

Winton Capital is one of Europe’s largest hedge fund managers with $25bn AUM. It primarily uses a trend following/ momentum, quantitative approach across many asset classes so at first sight Harding was an odd guest at a value conference.

After reading Joel Greenblatt’s Little Book That Beats the Market, Harding became interested in utilising value in a systematic way. He said that Winton’s research findings echoed Greenblatt’s research finding a real edge using quantitative value. Winton do incorporate a value approach into some of their trading, although it did sound as if it was a side show compared to their main trend following approach.

The key value metrics that Harding discussed were return on assets and earnings yield. He noted that results could be significantly improved by equal weighting stocks rather than using capitalisation weighting.

Gary Channon is strongly influence by Warren Buffett and Phil Fisher. Phoenix is long-term, focused, looking for great businesses run by shareholder aligned managers, companies with strong pricing power, generating a high returns on capital. In short, they look for long-term greats.

The Phoenix portfolio usually has around 15 stocks with the top 5 making up >60%. All the stocks are UK listed. They carry out detailed research with extensive fieldwork and monitoring. Since inception in 1998 Phoenix has returned 9.6% net annualised or 290% in total. On a total return basis the UK market has returned 4.6% per annum during the same time period. Phoenix have a high win/ lose ratio with 78% winners against 22% losers.

Channon talked about “Finding Opportunities in Flawed Heuristics”. A heuristic is a mental shortcut that allows people to solve problems and make judgements quickly and efficiently. Channon argued that investment heuristics like P/Es, price to book and EBIT lead investors to oversimplify and misunderstand companies. At times these commonly used heuristics fail to identify stocks that are really cheap creating opportunities for informed value investors.

Channon used the homebuilder, Barratt, as an example of how heuristics can fail. Historic cost accounting creates a distorted picture of homebuilders in a rapidly rising or falling housing market. The financial crisis wiped out IFRS earnings and made book value different from cost or market value. No earnings and an unfathomable book value left the market without its usual heuristics of P/ E and P/BV which in turn led to the stock becoming cheap.

Long Idea: Glaxosmithkline (LON: GSK)

Channon noted that the orthodox view of big pharma is that pricing power is being lost due to patents expiring and therefore companies deserve to trade on a lower multiple than they did in years gone by. Channon argued that this was a faulty heuristic.

Phoenix’s research on the pharmaceutical industry indicates that the pharma industry is not prone to creative destruction with open competition leading to lower prices, rationalisations and bankruptcy. Instead Channon painted a picture of pharma as being a cosseted sector, with high profitability, little cut throat competition and little change. The time horizons in pharmaceuticals are very long. All the big companies are at least 90 years old. It is hard for new companies to break into the large pharma sector. New products take 10-12 years to develop. Companies tend to keep a stable market share over time.

Glaxo has kept a steady market share at 5% for 30 years. You get stability and high returns due to industrial scale, not new drug development. Channon argued that patents are irrelevant to the long- term investor. National health care spending is much more predictive of profitability than the drug pipeline. Health care spending tends to go up over time as a proportion of GDP.

Channon likes the Glaxo management particularly the CEO Andrew Witty. He believes that Witty has successfully changed the culture with the company becoming genuinely socially responsible. For example, Glaxo is working with the Bill and Melinda Gates foundation, they are open with their drug test data and they are making some drugs available for free in poorer countries.

Denison-Smith’s investment strategy draws extensively on his experience of building and running businesses. He has extensive experience of private company buyouts. Since inception in 2008 Metropolis Valuefund has returned 12% per annum.

He likes to buy unloved companies but he noted it was difficult to execute the strategy consistently for a number of reasons. You need to be able hold your conviction when the market is selling off hard. You need to be able to treat volatility as risk. It helps to think of investments as a fractional stakes in a business. Avoid anchoring to an investment thesis as the facts change. Avoid over- diversifying, 10-20 stocks are enough. You have to be able to cope with periods of inactivity.

Metropolis apply an entrepreneurial and private equity approach to long only investing. They screen for cheap businesses and rule out most candidates using criteria such as sector, pension liability, clarity of business and unfavourable ownership structure. They spend most of their time assessing the quality of businesses carrying out analysis of multiple years of accounts, broker reports, web based research, modelling cashflow and identifying risks. The favour the sum of discounted future cashflows as a measure of value.

Denison-smith said that trying to fully understanding the bear case is an important part of their process. As Chalie Munger says, always invert.

Idea: Long Cisco (CSCO)

Since 1999 EPS has grown 13% pa. PE has fallen from a peak of 300x to 11-12x. EBITA margins have remained within the range of 26-34%. It consistently generates positive operating cashflow after interest and tax. Cashflow is consistently higher than reported profits. Today Cisco’s post tax cashflow is only costs 7x. Free cashflow yield is 14%. Cisco has a moat in terms of scale, brands and high switching costs. Denison-Smith noted that Cisco’s reputation for producing routers and switches that are the safe and reliable option was particularly important. The most significant threat to Cisco is that disruptive technology (SDN) and increased competition, particularly from Huawei, will impact their high gross margins.

Idea: Long J. Smart (SMJ: LON)

Denison-Smith billed J. Smart as an idea for personal accounts. J. Smart develop residential and commercial property in Edinburgh. They also provide a range of construction services for external and internal use. It is a family management team with 50% ownership and it is not covered by any analysts. They are buying back shares and there is a dividend of 4%. The shares are illiquid. It’s cheap in balance sheet and cashflow terms. The discount of enterprise value to net tangible book value less cash is 65-70%. EV: post tax FCF of 7-8x. FCF yield of 12-14%.

With the AUM of large value funds dwindling from its peak, Lance and Purves suggested that it was time for a little humility and introspection amongst value investors. They argued that the pace of technological change meant that value investors were often not well equipped to invest in technology companies as they tend to fixate on the accounts.

Another factor undermining the effectiveness of value investing in today’s market is that stock prices do not mean revert as much as they used to. This means that doubling down on investments is more risky. They speculated that globalisation prevents mean reversion and they gave the example of the pressure that large US car makers have been put under by global competition.

They pointed out that the last 30 years have been very generous to investors and that the next 30 years may not be so kind. Were the last 30 years normal? Could the next 30 years be different? Has anything changed permanently?

- The discount rate has fallen dramatically
- Government deficit spending has been high
- Household savings have fallen
- Corporate profitability is at record levels
- The aggressive actions of central banks have supported markets

Looking forward they feel the last 30 years was abnormal. The future could well be harsher. We should look out for corporate lifecycles getting shorter. Investing in low valuation stocks may not work so well. We will need to be more selective about our investments. Sustainability of cash flow will be very important.

The theme of Jeremy Hosking's presentation was how the money management industry can produce opportunities for value investors. There is a limited amount of opportunity in markets and we are all fighting over it, Hosking said. It helps to have someone making opportunity at the poker table and that is a role often played by institutional asset managers. Institutional funds cause:

- Agent principal damage via high fees
- Diseconomies of scale. The bigger the pool of assets the harder to outperform
- Product proliferation (often at the top of the market)
- Herding by fund managers is a disservice to the client

And while Hosking talked about herding, it is slightly ironic that he then went on to pitch AIG. While the bull case on the company makes sense, it is held by many prominent US hedge funds as a top long and could be considered a 'herding' pick in and of itself. But to be fair, perhaps it's not a consensus long over in the UK.

Richard Titherington is the Head of the JP Morgan Emerging Markets Equity Team based in London. In terms of price to book General Emerging Markets (GEM) is cheap but not at crisis levels. Because corporate governance is shareholder unfriendly in many emerging markets, GEM may not actually be that cheap. For example, many Indian and South Korean companies do not pay dividends.

Titherington likes China, Korea and Russia. He said that China is in the sweet spot, having both good value and momentum. His main message was to buy what is cheap and unpopular and to sell what is expensive and popular. Thailand and Indonesia are particularly expensive whilst Chinese financials offer significant value.

Disclaimer

The content provided within this website is property of MarketFolly.com and any views or opinions expressed herein are those solely of MarketFolly.com and do not represent that of any firm or institution. This website is for educational and/or entertainment purposes only. Use this information at your own risk. MarketFolly.com is not an investment advisor of any kind, so do not consider anything on this page to be legal, tax, or investment advice. MarketFolly.com is not responsible for any third party links or content. MarketFolly.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to amazon.com.